France, Germany want clampdown on speculation

Merkel and Sarkozy call on EU to consider banning trading in one financial derivative and to tighten regulation of all derivatives trading.

The leaders of France, Germany, Greece and Luxembourg have asked the European Commission to consider banning or limiting trading in credit defaults swaps linked to government bonds.

The request, which was sent to the EU executive yesterday, comes in response to concerns that financial market speculators are making Greece’s financial problems worse by driving up the cost of borrowing.

Credit default swaps (CDS) are a form of insurance that investors can buy to protect themselves from default on debt. The leaders accuse speculators of buying and selling CDS on Greek debt to earn a quick profit, with the side-effect of driving up the yields on Greek bonds.

The letter, which was signed by French President Nicolas Sarkozy, German Chancellor Angela Merkel, Greek Prime Minister George Papandreou and Luxembourg’s Prime Minister Jean-Claude Juncker, says: “We must prevent speculative actions from causing so much uncertainty on the market that prices no longer provide accurate information and state financing reaches a fundamentally unjustifiable level.”

Their letter, which was addressed to European Commission President José Manuel Barroso and José Luis Rodríguez Zapatero, who, as prime minister of Spain, heads the EU’s rotating presidency, asks the Commission to launch an inquiry into the “role and impact of speculative practices” in CDS trading associated with European government bonds. If the inquiry shows that there have been “market abuses or that speculative practices are having a considerable impact on the development of yields, we should quickly examine measures to determine whether they are suitable, and, if necessary, pass the appropriate legislation,” the letter says.

The letter says that this examination should consider “banning speculative CDS trading”, as well as banning investors from buying CDS that insure assets that they do not own (a practice known as naked short selling).

The leaders also want the Commission to “consider introducing minimum holding periods” for CDS to prevent the kind of quick buying and selling that they blame for exacerbating Greece’s problems.

More broadly, the leaders call for greater regulation of the market for derivatives, a term that covers a wide range of complex financial instruments, of which CDS are just one example. They want “mandatory reporting of all derivative transactions to a trade repository located in Europe” and also data-sharing with “non-European trade repositories”.

Sarkozy, Merkel and Juncker also give their backing to efforts under way in the Commission to push derivatives trading onto exchanges, or through central counterparty clearing, so that it can be better monitored. Central counterparties (CCPs) are financial firms that act as a buyer to every seller and a seller to every buyer on the market, which in turn makes trading more transparent and more orderly. The leaders call for European CCPs to be based “within the euro area” – a pot shot at London, where many clearing services are currently based.

The Commission should present the results of its efforts to the EU’s finance ministers, the leaders write.

The Commission’s plans

Barroso earlier this week pre-empted some of the requests in the letter by announcing his own set of initiatives for regulating trading in CDS and other derivatives.

Barroso told the European Parliament on Tuesday (9 March) that the Commission will “examine closely the relevance of banning purely speculative, naked sales, on credit default swaps of sovereign debt”. He described the buying and selling of CDS “on a purely speculative basis” as unjustified.

In addition to Barroso’s initiative on sovereign debt, Michel Barnier, the European commissioner for the internal market, is currently preparing a review of EU legislation on financial market abuse, and is considering including a ban on naked short selling.